The Dangers of the Payday Loan Trap

The New York Times published an article last week about the growth of “payday loan” stores — places that give a short-term, high-interest loan as an advance against your next paycheck. The article revealed some bleak results for people who use these services:

Mr. Milford is chronically broke because each month, in what he calls “my ritual,” he travels 30 miles to Gallup [New Mexico] and visits 16 storefront money-lending shops. Mr. Milford, who is 59 and receives a civil service pension and veteran’s disability benefits, doles out some $1,500 monthly to the lenders just to cover the interest on what he had intended several years ago to be short-term “payday loans.”

The article notes that these loans are effectively banned in 11 states, but are legal and growing quickly in the other 39. There are some terrible anecdotes included about the effects of these loans:

“Payday lending just keeps growing, and it just keeps sucking our community dry,” said Ralph Richards, a co-owner of Earl’s, Gallup’s largest and busiest restaurant.

Mr. Richards sees the impact among his 120 employees, mainly Navajo, some of whom become trapped by payday loans they cannot repay and, he said, “develop a sense of hopelessness.”

In one indication of how common the problems are, his restaurant alone gets 10 to 15 calls each day from payday lenders trying to collect overdue fees from his workers, Mr. Richards said. At any one time, under court order, he must garnish the wages of about a dozen of his workers to repay such lenders.

Reading this hit home for me. While I’ve never gone to any of the storefront places that the article discusses, for a couple of years, I was a very frequent user of a similar service offered through Wells Fargo ATMs. Called “Direct Deposit Advance,” the Wells program offered you up to $200 advance on your next paycheck, as long as you had direct deposit set up on your account. I think the fees for a $200 advance were $20. My situation was nowhere as bleak as the stories in the article, but I had exactly the same bad cycle: every paycheck, the first thing I would do is go to the ATM and take an advance on the next paycheck. After this had gone on for a while, I realized that I had been doing it every paycheck for more than a year.

So what was the result for me, in a much less desperate circumstance? Over the course of a year, I took 26 advances at a cost of $20 each — a total of $520. What did I get for that? For one paycheck, I had access to $200 more. That’s it — after that, each advance only served to pay off the previous advance. I paid $520 paid to get a short-term loan of $200.

I was fortunate that I had a good job, and even though I had accumulated a lot of expenses, I was able to break the cycle and get out of the $200 advance trap. The worst part was that the habit was so easy to perpetuate — just drop by the ATM, and the cycle continues. I didn’t even realize how long it had gone on until I added everything up for the year (using Quicken, which I had let lapse during that year) and saw the same transaction every two weeks. I was able to cut back on a few expenses and get out of the trap.

(Later, though, I got a “short-term loan offer” from Wells Fargo — a check for $1,500 that just showed up in the mail. I cashed it, and then spent months repaying it. The same problem in a different form.)

The people in the Times’ article have it much worse — their interest rates are higher, they have multiple loans to repay, and their jobs are not going to allow them to break out of the cycle anywhere near as easily. For me, I just had to decide to get out of it and work at it for a few weeks; for them, it will be months or years of effort. As Ralph Richards says in the quote above, the effects of this are not limited to the people who take the loans, but of course also to their families, their employers, their friends, and their community. Who benefits from that?

If you see a payday loan store moving into your community, my advice is to fight it. I see these businesses as predatory, and nothing more than a fancy neon sign on top of old-fashioned schemes for usury. But don’t just stop at worrying about payday loan storefronts — they’re the worst, but the credit industry offers these “products” in many forms, and you can easily get caught in renewing a short-term loan at great expense.

The basic lesson for personal finance is the same you’ll have heard many times, but it always bears repeating: If it seems like you’re getting easy money, watch out!Easy money is the hardest kind there is.

Agreed on the predatory nature of these places. The key is to STAY AWAY. And tell everyone you know to stay away. If you calculate out interest on these things it ends up being something like 800 percent. No one can get ahead paying fees like that.

While I agree that you’ll never get ahead using Pay Day loans, I’m think everyone is having way too much fun picking on them as a great scourge on society. If you look at it rationally, a large chunk of the $20 fee on a $200 cash advance is actually going to be consumed in admin costs for issuing the loan (just recording all the required details to lend to $200 would easily consume $10 worth of time). And the “interest rate” on such loans also has to be high enough to compensate for the bad risk of most of these borrowers. If there was as much “fat” in the margins as bloggers and journalists seem to believe, they’d be even more of these lenders starting up than is the case.

Just as an aside – work out the “APR” lots of people are paying just for the privilege of withdrawing their OWN cash from an ATM. Lots of people think nothing of taking out $10, $20 or $50 at a time, when they will be charged a fee of $1.50 for the privilege. Even here in Oz where most banks and credit unions charge no ATM fee for withdrawals, many customers are so lazy that they use “other” bank’s ATMs for a cash withdrawal, and pay an unnecessary fee.

Payday loans are just another reason why personal finance and asset management ought to be taught in schools, especially before college (and the attendant tide of credit card offers). Wise kids up early, and they’ll never see these predatory loans as a viable option.

My only concern with outlawing payday loan places is the alternative: loan sharks.

People go to payday loan stores because they need money they don’t have, and they can’t get a loan elsewhere. Even taking a cash advance on a credit card is cheaper, so the customer base is probably one step removed from selling their own blood for cash.

If these people really need money (or at least convince themselves they do), they’ll find a way to get it. That gives loan sharks a foot in the door, and their collection tactics make wage garnishment look like a walk in the park.

Oh how I remember the Wells Fargo direct deposit advance. I found myself using it quite a bit about 6 years ago. I quickly found myself having to use it again and again to cover the previous usage. It took time and some restraint, but I got out of it. I’ll second that our schools need to teach classes on personal finance.

I used Payday loans a few times back in grad school when I needed money for to get to the next paycheck. Obviously, I wasn’t too responsible to have gotten myself into such a situation, but given that I was in that situation nonetheless, I think I handled it reasonable well. I didn’t get huge advances–just the bare minimum to get my by. I did this just a few times until I got my expenses in a little better order. Yeah, the interest sucks, but the PayDay loan places are not to blame. I was. And every other person who uses them is responsible for their own actions. If you want pass a new law, pass a law against financial stupidity.

Thanks J.D. for inserting this piece in your blog. The fact that these predatory practices are allowed in our communities is beyond comprehension. The greed upon which these businesses are built is so blatant, it’s almost surreal. Everyone should think about their guilt by association (as part of the human community) every time they drive by one of these neoned establishments. Those who care about financial security for all should do what they can to make these high-interest, short term loans illegal. What is particularly hopeful for me is that it is not just “those down and out” that fall victim to these modern-day loan sharks. Many of your readers seem to have been affected as well. This will make it easier for our society to rid itself of this scum.

I’m not surprised the example given is in New Mexico. Here in Albuquerque we must have more payday loan places here than anything else. There’s literally one every other block. The other thing we have a lot of here is poor people, which I would imagine is not a coincidence. I’ve heard multiple people here tell me they used a payday loan place to “build their credit” as well, which boggles the mind even further.

For a variety of reasons, I’m solidly in the “these things should be outlawed” camp. In general, I think the deregulation of credit card companies and high-risk loan organizations have been damaging – and should be reversed.

Question is, how does one push for this? It’s not something that comes up much in political campaigns… does there even exist a lobby group lobbying for restoring the regulation of high-risk lending?

I hate these places. They prey on our young service people a LOT. My son knows to stay away, but a lot of his Marine buddies have been suckered in. And these are kids that at least had a few financial management classes in boot camp! So I’m not sure that education alone is enough.

The Oregon Food Bank released something a few months ago stating that an awful lot of people in Oregon getting payday loans were doing so just to buy food for their family. Certainly, payday loans are indicative of a larger societal problem if folks are getting caught in cycles of debt just so they can eat. I definitely agree that they should be made illegal, however.

The loan shark comes up looking better than the payday loan companies: lower interest rates, reputation for violence exaggerated. The author argues that this is because the payday loan companies have an effective government monopoly on certain niche loans. One proposal to deal with this is to push loan sharking aboveground — bring it into the legal universe — to provide sharper competition to the payday loan guys.

To paraphrase Dave Ramsey, have you noticed that these types of stores aren’t in rich neighborhoods? Not because rich people don’t need it, but because rich people wouldn’t BUY it, THAT* is what made them rich.

“That” being a behaviour model that means acting like a responsible grown up, having some patience and not trying to microwave a money problem.

I’m willing to bet that the immature instant gratification behaviour model in this country is the leading cause for people’s money problems and ultimately leads to their bankruptcy. In fact, I know it is, because if people didn’t *have* to have something *right now*, they wouldn’t pay 90 days same as cash, put it on mastercard, or use payday loans to cover their bills because they didn’t plan how they were going to spend their money (ie, budget!).

[...] is similar to pieces I’ve featured before, including Marc Hedlund’s guest-post on the dangers of the payday loan trap and my own review of Maxed Out, a film about the credit industry. In this new article, authors [...]

[...] So, basically, you’re paying Pay Day Loan-like fees to get your money in… oh… about the same amount of time you’d have gotten it anyway. And if you don’t already know that Pay Day Loans are bad deals, well… now you know. [...]

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